Litigation in franchising: where does it come from, how to prevent it, how to solve it

Franchising networks, in Italy as well as all over the world, are often characterized by a high level of conflict within them, which can lead to disputes. The causes of litigation in franchising are on the one hand common to all commercial contracts (contractual breaches), but on the other hand specific to the franchise, as they can be linked to structural characteristics of this relationship. Every franchise network should prevent conflict situations as much as possible and effectively manage the conflict that has arisen, with the appropriate assistance of a lawyer expert in franchising. This objective is possible, with a series of appropriate measures and strategies that must be adopted by each franchisor, albeit differentiated according to the sector in which the network is active. In this article we analyze the most typical and recurring causes of conflict in franchising, providing some indications to franchisors to prevent litigation and resolve it effectively.

1.Main features of litigation in the franchising context

Franchise networks, in Italy as well as throughout the world, are often characterized by a high level of conflict within them, which often leads to litigation. Litigation in the context of franchising can be briefly divided into two main “strands”. A first line of litigation – which we could call “ordinary” – is linked to causes that are also found in almost all other business contracts, as essentially connected to contractual breaches, committed by one or the other party (i.e. by the franchisor or franchisee).

From this point of view, franchising does not differ much from other commercial contracts, which all present, to different degrees, a “physiological” litigation rate, deriving from the fact that the contractual obligations may not be fulfilled, in whole or in part, thus giving rise to disputes. Even this “ordinary” line of litigation has, within it, peculiarities that are connected to the specific obligations envisaged in franchise contracts (and which are not found in other contracts), as we will see below.

But there is a second line of litigation in franchising, which differs considerably from what we find in other commercial contracts, as it is connected to the peculiar characteristics of the franchise.

In a certain sense, we can say that in franchising there is a “physiological”, or rather structural, conflict between franchisor and franchisee, deriving from two main causes.

First, signing the franchise agreement, a very close bond is created between franchisor and franchisee, which considerably affects the latter’s activity; in fact, the franchisee, although legally an independent entrepreneur, is not free to make decisions as a commercial entrepreneur normally is, as the franchisor exercises a very penetrating control over his business, severely limiting his freedom of action through a series of contractual clauses, almost always inserted in the contractual forms adopted by the franchisors.

I am referring, just to give examples, to the clauses that require the affiliate to:

• adopt a specific furnishing of the premises of the point of sale;
• purchase certain products or services exclusively from the franchisor;
• use a particular management software provided by the franchisor or its suppliers;
• carry out specific advertising and/or support certain advertising investments;
• allow periodic checks and inspections regarding its activity;
• charge certain sales prices to the public;
• purchase a certain minimum of products from the franchisor or its suppliers;
• grant the right of first refusal and/or acquire the approval of the franchisor in the event of the sale of the business,

etc.

 

These clauses are, in general, perfectly legal, as they are functional to allow the franchisor to preserve three absolutely fundamental values in franchising: uniformity of the network, commercial image of the network, and know-how.

At the same time, however, the same clauses, as they are highly restrictive of the entrepreneurial autonomy of the franchisee (and therefore of the competition), can be a source of litigation, which often emerges when the franchisee’s business does not proceed well (for example because the franchisee does not achieve the profitability that he had thought of achieving or that had been proposed to him).

Secondly, while the needs and interests of the parties (franchisor and franchisee) largely coincide at the beginning and during the duration of the contract, they often tend to diverge dramatically at the time and after the termination  of the contract; not surprisingly, a large part of the dispute that is registered in the networks refers precisely to this phase.

Let’s think of just two examples (which we will focus on later), very often harbingers of litigation:

• one of the parties (franchisor or affiliate) intends to withdraw from the contract early (this problem arises in particular when it is the affiliate who wishes to withdraw from the contract without this being provided for in the contract itself, as will be seen);
• once the contract is terminated, the franchisee intends to continue to carry out an identical or similar activity to that which he carried out in the franchise network, but who is precluded by a post-contractual non-competition agreement.

In these examples (but others can be done, as we will see), franchisors and franchisees, who had coexisted without problems in the force of the contract, suddenly find themselves having diametrically opposed interests, with the consequent (but avoidable, as we shall see) arising of the dispute.

2.Why is it better to avoid litigation in a franchise network?

This question may seem all too obvious, but it is always advisable to highlight the reasons – and there are many – for which it is advisable for a franchising network to avoid, in general, litigation with franchisees, limiting it to the bare minimum.

Here is a list of the main reasons why a franchise dispute should be avoided:

• the long duration of judicial proceedings in Italy: a trial at first instance (omitting the appeals degrees) before the ordinary judicial authority currently lasts an average of 3-4 years; definitely too much, given that in this period there is still a situation of uncertainty (no dispute is in fact ever a certain outcome), which prevents the franchisor from planning its choices. On the other hand, there are much shorter times for arbitration (one of the reasons why it is in fact advisable, as will be seen below).
• the general lack of knowledge of franchising by many judges: although it is obviously not possible (nor right) to generalize, many judges do not sufficiently know franchising in its technical and operational aspects, and therefore risk making decisions based on an erroneous or insufficient understanding of the phenomenon. Such risk is much less present when it is an arbitrator who decides; which represents a further reason why this method of dispute resolution is preferable, as we will see).
• the franchisor’s interest that the franchisee continues to be part of the franchise network; in fact, a dispute implies, in 99% of cases, the termination   of the relationship with the franchisee, which is not always a good result for a franchising network.

• possible damage to the image of the franchise network: if a dispute ends in a negative way for the franchisor, the franchise network can suffer serious brand damage, given the notoriety that can be given on the media and on social networks.
• possible disincentive for future affiliations: the franchisor is in fact obliged, pursuant to Italian Franchise Law no.129/2004 to inform the potential affiliate about the dispute in the network (even if only referring to the final sentences), for which a negative measure can constitute a major obstacle to affiliate by the potential interested parties.

This does not mean, of course, that a dispute over a franchise network is never justified: There are in fact cases in which the dispute is necessary, such as when it comes to protecting the franchisor’s brand or know-how (and not only).

But in general, every franchise network should prevent the emergence of conflict situations as much as possible and effectively manage the conflict that has arisen, with the appropriate assistance of a lawyer really expert in franchising .

As we will see, this objective is possible, with a series of appropriate measures and strategies that should be adopted by each franchisor, albeit differentiated according to the sector in which the network is active.

In this article I will analyze the most typical and recurring causes of conflict in franchising, and I will provide a series of indications to franchisors to prevent litigation and resolve it effectively.

3.Failure to fulfill contractual obligations: a) by the franchisee

Starting the review of the main causes of disputes in franchising, let’s first analyze those deriving from the non-fulfillment of the obligations set out in the franchising agreement.

As far as the affiliate is concerned, the most recurrent non-fulfillment is that consisting in the non-payment of royalties  or of the purchase prices of the products). In fact, debt collection from franchisees is an ever-growing cause of dispute in the franchise, especially following the current economic crisis caused by the Covid-19 pandemic.

Failure to pay the fee by the affiliate is generally linked to the occurrence of two situations:

• when starting the franchise business (start up), by the investments initially made by the franchisee and by the low income initially deriving from the activity;
• during the relationship, by situations of financial tension, linked to unfavorable market conditions or unexpected events (such as recently the Covid-19 pandemic).

Taking this into account, the first indication to try to prevent this type of situation is to implement a business strategy aimed at ensuring that affiliates can carry out their business profitably, and therefore:

• in the initial phase of the franchising relationship, especially when the franchisee has little experience or the market conditions are not advantageous, the franchisor should provide for reduced royalties and/or price margins, also in relation to what has already been paid by the franchisee as entry fee and/or investments, in order to encourage the affiliate and avoid the emergence of situations of conflict.
• fully operational, the franchisor should provide for realistic royalties and/or price margins, in light of actual market conditions, in order to allow an effective and sufficient profit margin for the franchisee.

The second tip is to carefully and constantly monitor the financial situation of the franchisees. In this sense, it is appropriate:

• if variable royalties are envisaged (based on turnover), provide in the franchise agreement for the franchisor to carry out audits, also regulating the consequences in the event of a discrepancy between the data ascertained and those communicated by the franchisee, and providing for a penalty clause in the event of deviations exceeding this threshold, until the termination of the contract;
• in any case, evaluate promptly and analytically the actual financial situation of the affiliate and the real reasons for the affiliate’s lack of profitability;
• take a series of initiatives to improve the affiliate’s profitability (for example: improve the promotional/advertising policy; review the costs of products/services to affiliates and the market; suggest cost savings to the affiliate e.g. on staff; devise new ones products/services etc.).

Of course, there can be many other contractual breaches by the franchisee; we will deal with them by analyzing the specific litigation causes peculiar to the franchise.

4.Failure to fulfill contractual obligations: b) by the franchisor

Let’s see now the contractual breaches attributable to the franchisor. Statistically, the most frequent contractual breaches committed by the franchisor consist of:

•  failure/incorrect provision to the affiliate of contractually provided services (e.g. start-up assistance, marketing, etc.);
• failure/incorrect supply of goods to the affiliate (for example, products delivered late or not compliant with those ordered by the affiliate);
• failure/inadequate provision of training to the affiliate (initial or ongoing);
• violation of the exclusive territory   assigned to the affiliate.

In these cases, despite the fact that franchising contracts generally do not provide for the immediate and automatic termination  of the contract (express termination clause, pursuant to Article 1456 of the Italian Civil Code) in the event of non-fulfillment by the franchisor (unlike what is instead provided for contractual breaches of the franchisee), if the breaches of the franchisor are  serious  (such as in the case of violation of the exclusivity) the franchisee can still request the termination of the contract for breach by the franchisor (Article 1455 of the Italian Civil code), in addition to compensation for damage suffered.

Therefore, to avoid incurring in disputes related to default by the franchisor, the first suggestion is therefore to include in the contract services from the franchisor to the franchisee only if the former is actually able (or possesses the organization, ability, competence, etc.) to provide them, to avoid being faced with possible disputes about the failure or incorrect delivery.

The second tip is to limit contractual services in favor of affiliates as much as possible, and in any case to accurately describe such services in the contract. Too often I come across contractual clauses in which the franchisor generically (and “generously”) provides in favor of the franchisee “financial assistance, marketing, management etc. in the start-up phase “; these clauses can prove to be a sensational boomerang for the franchisor in the event of a dispute by the franchisee. Let’s not forget that the franchise agreement is not an advertising tool!

Finally, it is advisable (indeed necessary) to document as much as possible everything that refers to the fulfillment of contractual obligations by the franchisor and to carefully keep this documentation (think for example of the documentation relating to the provision of training, the provision of assistance in the start-up phase, and so on). In fact, in the event of a dispute, if the franchisee contests the franchisor’s non-fulfillment, from a legal point of view it is the latter who must prove the fulfillment; if he fails to provide such proof, he will be considered in default, with all the consequences of the case.

Finally, as is obvious, if the contract provides for services to be paid by the franchisor, the latter must effectively and punctually perform them in favor of the franchisee. This is not only because it is a contractual obligation, but also because it denotes the correctness and seriousness of the franchisor. Let’s not forget that franchising is characterized, compared to other commercial contracts (such as for example sales or licensing contracts), also in terms of services (in particular training and assistance) that the franchisor provides in favor of the franchisees, and which justify the payment by them of entry fees and royalties.

5. Non compliance with pre-contractual obligations pursuant to Law no. 129/2004

Italian Franchise Law no.129/2004 provides for some specific disclosure obligations in favor of aspiring franchisees, which must be fulfilled by the franchisor before a franchising contract (or other legally binding document, such as a preliminary contract or an option contract) is signed.

Italian Franchise law protects aspiring franchisees – considered weak contractors compared to the franchisor – by granting them a period of at least 30 days before signing the contract, in order to carefully evaluate the proposed commercial affiliation, also with the help of their own consultants.

It is surprising to note how, many years after the entry into force of Law no. 129/2004, still many franchisors do not comply, or do not fully comply, to the pre-contractual information obligations provided for in favor of aspiring affiliates.

Yet these are relatively simple obligations – which should not present particular problems for a franchisor, if assisted by a valid legal consultant  the violation of which exposes franchisors to very serious legal consequences, even being the nullity of the franchise agreement.

Failure to comply with these obligations is generally not a source of litigation per se (since it is unlikely that the affiliate has an interest in contesting such non-compliance if the relationship goes well and without problems), but it can become so later as the affiliate, after having signed the contract, can invoke such non-fulfillment to defend himself from the franchisor (perhaps in the context of debt collection) or to support his claims for damages, for other reasons (perhaps for the lack of profitability of the activity).

Therefore, it is of fundamental importance to strictly comply with the provisions of Italian Franchise Law 129/2004, making use of the advice of a lawyer expert in franchising   and consequently:

• provide the aspiring franchisee, at least 30 days. before signing the franchise agreement, with up-to-date, complete and truthful information;
• provide the aspiring franchisee, at least 30 days. before signing the franchise agreement, with complete copy of the franchise agreement, and in case of significant changes, wait 30 days. before signing;
• limit the denial of information for real and serious reasons of confidentiality, indicating them in the contract.

Furthermore, in order to prevent any future disputes by the affiliate, it is advisable:

• pay attention to the franchisee’s requests for information and document their responses;
• document the reasons for confidentiality for which it was possible to avoid providing information to the aspiring franchisee;
• once the negotiations are concluded – and in any case at least 30 days. before signing the franchise agreement – have the aspiring franchisee sign a document in which it is acknowledged that he has received the contract and the information documents required by Law.

On the other hand, compliance with the provisions of  Italian Franchise Law  (which in reality does not foresee many obligations for franchisors) is, beyond a legal obligation, a proof of seriousness and fairness for every franchisor company: a sort of business card for a franchising network.

6.The Know-How

Know-how is a fundamental element in a franchise agreement,  Italian Franchise Law no. 129/2004, provides specific requirements in this regard, prescribing that know-how must be:

• secret, that is, “not generally known nor easily accessible”;
• substantial, that is, it must include the “essential knowledge of the franchisee” to carry out the activity;
• identifiable, that is, “described in a sufficiently exhaustive way”.

In summary, the know-how must allow franchisees to stand out on the market and differentiate themselves from the competition; therefore it must be able to give franchisees a substantial and stable competitive advantage.

If this is not the case – that is, if a franchising network lacks valid know-how  – a serious problem arises, a source of serious litigation risks for the entire franchise network: this is because the lack or lack of this fundamental element is likely to cause the nullity of the franchise agreement (and therefore of all franchise agreements, or the collapse of the entire network), with the consequent right of the franchisees to obtain reimbursement of the amount paid to the franchisor in addition to compensation for damage.

Furthermore, in this case the franchisor may face penalties imposed by the Italian Antitrust Authority (AGCM) for misleading advertising, pursuant to Legislative Decree n. 145/2007.

Also in this case, the lack of  know-how  is hardly a source of dispute in itself, as the franchisor is unlikely to have an interest in contesting this aspect with the franchisor if the relationship proceeds without problems), but it can become so later, when the franchisee can invoke this serious gap in the network to support his claims against the franchisor.

The lack of know-how is not an aspect that can be easily remedied “in progress”, that is, after the franchising network has developed and the contracts with the affiliates have already been signed. This would in fact presuppose the possibility of introducing new substantial elements in the franchise concept, and therefore of revolutionizing the entire network to a large extent; and in any case, the subsequent introduction of these changes could not remedy the initial nullity of the contracts.

It is therefore of fundamental importance to pay close attention to the valid configuration of the know-how  in the initial planning of the network, that is, in the preparation of the feasibility study. In this phase, not only must the requirements be carefully evaluated so that valid know-how can be talked about, but also the tools through which the know-how is transferred to the affiliates, i.e. training and the operating manual.

8.Failure/insufficient profitability of the affiliate 

Probably the most consistent thread of conflict in franchising networks derives from the fact that the franchisee does not achieve the profitability expected from his business, or that had been promised by the franchisor before signing the contract.

Most often, this situation arises from the business plan  which is often delivered by the franchisor to the aspiring franchisee – spontaneously, in that there is no legal obligation for the franchisor to provide this document, which does not fall within the disclosure obligations provided for by  Italian Franchise Law no.129/2004  -and which contains data or forecasts of turnover which then, on time, are not realized, for various reasons.

Generally, the franchisee is legally considered an independent entrepreneur, who fully bears the business risks, often linked to objective market situations or to the subjective capacities of the franchisee itself. Therefore, the lack of profitability of the franchisee’s activity can, in principle, never be attributed to the franchisor, and never constitute a source of responsibility for the latter.

This principle also applies if the franchisor delivers a business plan to the aspiring franchisee; in fact, there is no liability on the part of the franchisor towards the franchisee if the latter does not actually achieve the profits that were pervaded in the business plan, given that the franchisor does not assume any obligation of result towards the franchisee.

Having said this, it should nevertheless be pointed out that the failure of an affiliate to realize the forecasts of a business plan can in any case place the franchisor in a situation of risk.

This happens when the business plan delivered to the franchisee contains inaccurate, incomplete or even false data or information. In this case, given that the franchisee inevitably relies on the business plan in the course of negotiations – and indeed it is an often decisive element to push a subject to become affiliated with a certain franchise network  – the same can obtain the termination of the contract of franchising for willful misconduct or error, with consequent compensation for damage, if he can prove that he has been misled or mistaken.

There is also another, perhaps even more important, aspect of risk for the franchisor. The business plan is in fact an advertising tool, and as such is subject to the assessments of the Italian Antitrust Authority (AGCM). A business plan containing untrue statements, or in any case the truthfulness of which is not objectively demonstrable, about the profits deriving from commercial affiliation, could therefore be considered  misleading advertising  and therefore can expose the franchisor to even high financial penalties by the AGCM, as well as negative publicity (given that the provisions of the AGCM are published on the Authority’s website and they are widely disseminated in the media), with the consequent repercussions on the brand image.

And in fact, in numerous cases the AGCM has already imposed penalties on various franchisors for having generated false expectations of aspiring affiliates with misleading advertising messages of various kinds about the economic results achievable through affiliation, for example by prospecting “certain” earnings. when, on the other hand, they were in reality highly uncertain, as they depended on the most diverse variables.

Furthermore, the provisions of the AGCM that ascertain the deceptiveness of a business plan could be exploited by the affiliates before the judicial authority to obtain the cancellation of the franchise agreement and compensation for damage, given that the Authority’s findings constitute a very relevant clue, which cannot fail to influence a judge.

Therefore, to avoid litigation situations, it is important to prepare a business plan, and more generally advertising material, correct, reliable and truthful, avoiding that it can be a source of reliance for the affiliates about the results of their business and overcoming the natural tendency to “magnify” beyond the convenience of joining a given network.

Of course, it is still advertising, and you know advertising must be attractive; but attracting tens or hundreds of affiliates with “inflated” advertising then risks turning out to be a boomerang when the promised and advertised results do not arrive. Much better therefore to anchor oneself on correct and truthful data; which, among other things, indicates the seriousness of any franchising network.

Furthermore, always with a view to preventing any disputes, it is advisable:

• to deliver a business plan only if you have certain and demonstrable data; if in doubt, provide conservative and prudential data rather than too optimistic;
• to clarify with specific warnings that these are mere forecasts and not certain and binding data (given that the profitability of the business depends on many variables independent of the franchisor, such as market areas, general market trends, competition activities, affiliate etc.);
• to enter data that are not abstract or generic but calibrated on the actual concrete situation of the individual franchisee (market, location, etc.);
• in case of deviation, to analyze with the franchisee the reasons with a collaborative attitude and monitor the progress of the franchisee over time.

 

9.Termination/renewal of the contract

As in all long-term economic relationships, even in franchising the moment of termination  of the contract is very delicate and a source of litigation. In fact, while in the phase of execution of the franchise agreement the interests of the parties tend to be substantially identical, in the phase of termination of the relationship they tend to diverge sharply.

The franchisor generally has an interest in obtaining the maximum result in economic terms and in avoiding situations of exploitation of the brand/know-how by the former franchisee; the franchisee has an interest in limiting economic damage and maintaining a certain freedom of action on the market.

In this phase, two opposite situations can occur, both of which are a source of conflict. On the one hand, it may occur (and this is the statistically most frequent hypothesis) that the franchisee wishes to terminate the contract early, before its natural expiry, for various reasons (often because he does not achieve the economic results he intended, or is even at a loss).

Franchise contracts often provide the possibility for the franchisor to freely withdraw from the contract before the term; this is lawful, provided that:

• adequate notice is given to the affiliate, in relation to the duration of the contract and the investments made;
• in any case, 3 years or a longer duration will elapse for the amortization of the affiliate’s investment;
• the franchisee has not been entrusted with the continuation of the relationship.

Generally, however, the early withdrawal of the franchisee is not allowed in the franchise contracts (and therefore it is not lawful), or it is foreseen at penalizing conditions for the franchisee (for example with the payment of heavy penalties, or for very specific and restricted reasons).

The failure of the franchisee to withdraw early is justified by the need to protect the franchisor’s know-how; however, in this way an element of rigidity is introduced into the relationship which can lead to conflict and be a source of litigation, given that the affiliate who for various reasons intends to terminate the relationship early, unable to do so with the withdrawal, will try to find other solutions (alleged irregularities in the contract, breaches of the franchisor, etc.).

Conversely, it may happen that the contract expires naturally, there is no automatic renewal (or it is provided for under certain conditions) and the affiliate intends to continue the relationship, for example in order not to lose the investments made or because there are no other alternatives of work. In this case, given that the franchisor’s consent is required (since automatic renewal is not envisaged), the latter may not agree to renew the contract, or may request different and more penalizing conditions; and therefore a dispute arises.

In both cases, situations of conflict can be prevented by regulating the severance conditions in the contract in a balanced way, balancing the interests of the parties as much as possible.

It may therefore be appropriate for this purpose to allow the affiliate to withdraw early (without forcing him to initiate a dispute), wisely regulating this possibility in the contract; for example, it is possible to predict that the affiliate:

• can only withdraw from a certain year of duration of the contract;
• must give adequate notice, in a fixed or variable measure in relation to the residual duration of the contract (for example: 6 months if the withdrawal is exercised in the third year of the contract, 4 months if it is exercised in the fourth year, etc.);
• is required to pay an amount as a penalty for early withdrawal, fixed or variable, as long as it is adequate.

In addition, it may be appropriate to provide for an automatic renewal of the contract upon expiration, unless terminated to be exercised within a certain (reasonable) term before expiration, at most circumscribing the conditions of non-renewal in the event of serious breaches committed by the affiliate.

10.The franchisor’s competitive activities

A recurring line of litigation within the networks is constituted by the violation of the competition obligations envisaged by the affiliate. It is quite rare for the affiliate to violate these obligations during the course of the relationship; more frequent is the case in which the violation occurs after the dissolution of the contract (for whatever reason it occurs: natural term, early termination, termination).

In fact, post-contractual non-competition agreements  are frequently included in franchising agreements, which oblige the franchisee not to carry out activities identical or similar to those carried out when he was part of the network, either directly or indirectly, for a certain period after the dissolution of the contract.

This clause is often a source of litigation, as the affiliate – who often did not realize the existence of this obligation at the time of signing the contract – finds himself, at the end of the relationship, deprived of the possibility of exercising the activity he it carried out previously when it was part of the network, perhaps the only one it is able to carry out or for which it has made significant investments; for this reason, the affiliate tries to challenge the validity of the agreement, so as not to be too damaged.

What can be done to avoid this type of dispute, and / or resolve it effectively? There are three suggestions in this regard.

In the first place, it is appropriate to limit the inclusion in franchising contracts of this clause to cases in which it is truly important and/or indispensable for the franchisor, that is, to protect the know-how. Franchise agreements do not always include a post-contractual non-compete obligation, for example in distribution franchising.

Secondly, it is essential to provide (in the contract) a lawful clause, that is, in compliance with the legislation (not only and not so much Italian, but E.U. law: hence the importance of consulting with a lawyer expert in franchising. Regulament CE n. 330/2010 (which applies to all franchise agreements having significant effects on the Italian market, or almost always), a post-contractual non-competition agreement is legitimate only if:

• it is necessary for the protection of the franchisor’s  know-how (see above);
• refers to goods or services in competition with those covered by the franchise agreement;
• it is limited to the premises in which the franchisee operated during the contract;
• it does not last longer than 1 year after the termination of the contract.

If the post-contractual non-competition agreement is valid, it can usefully be brought to court as an urgent precautionary measure. In order to obtain an injunction against the former affiliate (which means that the former affiliate will no longer be able to continue to carry out the competitive activity). Damages may also be requested in a separate ordinary judgment on the merits.

Finally, it may be appropriate to provide (in the contract) a way out for the affiliate, so that the latter, if he wishes (or needs to) carry out the same activity after the dissolution of the relationship, does not has only the alternative of litigation: for example, it may be appropriate to provide for the possibility of dissolving from this constraint by paying a penalty, as long as it is not excessive (otherwise the objective is not achieved).

Another hypothesis that occurs quite frequently is that in which the former affiliate, in addition to continuing to carry out activities similar to that carried out in the network, uses a trademark similar to that of the franchisor. This is a very serious and dangerous situation for the franchisor, which must be stopped immediately (also as an urgent precautionary measure, obtaining an injunction against the former franchisee).

However, the trademark registered by the franchisor must be effectively protectable, that is, it must be a strong trademark (so when it is not descriptive of the product/service of the owner, or otherwise renowned); if instead the brand is weak (therefore learned of distinctive ability), slight modifications by the former affiliate (or third parties) are sufficient to avoid confusion, and therefore to be legitimately used by these subjects.

11.Final Tips: a) avoid litigation with a “good” franchise agreement

Finally, some general indications in order to prevent conflicts in franchising and effectively resolve disputes that have arisen in the network. First of all, remember that the basis of any franchising relationship is the contract; therefore, the key to preventing disputes with franchisees is to structure a “good” franchise agreement.

This means that a franchise agreement should have three characteristics:

• be valid, that is, in compliance with the applicable general and special regulations (first of all Italian Franchise Law no. 129/2004  but not only); a franchising contract with clauses of dubious legitimacy is the best way to foment disputes.
• be effective, that is, containing the clauses that are really functional to protect the interests of the franchisor; for example, a well-drafted express termination clause, the possibility of suspending supplies/services in the event of default by the franchisor, congruous penalty clauses, personal or bank guarantees, and so on.
• balanced, protecting the interests of the franchisor but without being excessively and unjustifiably oppressive of the franchisee; an unjustifiably unbalanced contract in favor of the franchisor constitutes an incentive for litigation for the franchisee.

From this last point of view, it should be pointed out that the franchisee’s restrictive competition clauses are generally valid (provided that they are expressly signed pursuant to Article 1341 of the Italian Civil Code), but cannot excessively compress the franchisee’s entrepreneurial autonomy. In other words, they must be functional to guarantee the uniformity of the network and to protect the image and know-how of the franchisor. Otherwise they could be considered invalid because they constitute an abuse of economic dependence of the franchisor to the detriment of the franchisee.

12.Final suggestions: b) effectively resolve disputes with ADR systems (mediation and arbitration)

Finally, to effectively resolve a dispute it is important for a franchise network to resort to alternative dispute resolution methods to ordinary justice (ADR), i.e. mediation and arbitration.

Italian ordinary justice system has many limits, that make it, in general, unsuitable for solving the legal problems of businesses, and therefore also of franchising networks. This is not just an Italian situation: on average, about 90% of commercial conflicts in the world are resolved outside the courtrooms, precisely through alternative dispute resolution methods.

This means in the first place that a mandatory mediation clause should be included in the contract, thus making it necessary to contact a mediation institution before taking legal action. Mediation can allow a dispute to be resolved quickly and at a much lower cost than any dispute.

Secondly, an arbitration clause should be included in the contract, in order to devolve any disputes that may arise regarding the franchise agreement to arbitrators. Arbitration has two major advantages over ordinary justice:

• greater competence than professional judges;
• faster than the ordinary procedure.

The only drawback arbitration with respect to ordinary justice is constituted by the higher costs; however, costs can be contained by providing for an administered arbitration (for example by a chamber of commerce) and/or a single arbitrator.

 

Avv. Valerio Pandolfini

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The information contained in this article is of a general nature and is not to be considered an exhaustive examination of the various issues, nor is it intended to express an opinion or provide legal advice. Specific legal advice must be provided with regard to individual cases.